The Last Time DOJ Sued to Block a Vertical Merger was Over Forty Years Ago . . . And It Lost

On November 20, 2017, the Department of Justice (“DOJ”) filed suit in the District Court for the District of Columbia to block AT&T’s attempted acquisition of Time Warner Inc. AT&T (through its cellular network, its fiber-optic television distribution service U-Verse, and its ownership of DirecTv) is a video distributor, and Time Warner (through its ownership of cable networks like TNT, CNN, and HBO) is a video producer. Because the companies primarily operate in different parts of the supply chain of program content, they do not directly compete with one another. A combination of two such companies is known as a “vertical merger.” The DOJ’s decision to try and block AT&T’s bid surprised many observers because it is unusual for the government to object to a vertical merger;[1] in fact, the last time the DOJ actually filed a lawsuit to block or dissolve a vertical merger was forty years ago.

What happened when the DOJ brought that suit forty years ago? It lost.

In United States v. Hammermill Paper Co., 429 F. Supp. 1271 (W.D. Pa. 1977), the DOJ sought to force Hammermill, a paper manufacturer, to divest itself of two paper distributors (known as “paper merchants”) it had acquired in the 1960s. According to the DOJ, these acquisitions violated Section 7 of the Clayton Act by “substantially lessening competition” in the market for the “manufacture and sale of printing and fine paper.” Id. at 1274.

The court first determined that the manufacture and sale of printing and fine papers is not a concentrated market, noting that in 1967 Hammermill only had a 4.98% national market share and that the nine largest manufacturers possessed a combined market share of under 50%. Id. at 1274-75. The paper distribution business was even less concentrated. Id. at 1275-77. The DOJ argued that the relevant market was paper distribution in New England, where one of the acquired paper merchants, Carter Rice, accounted for nearly one-third of total paper merchant sales of printing and fine paper in 1967. Id. at 1277-78. The court rejected this argument, finding that paper mills and merchants, respectively, sell and buy paper nationally, not regionally. Id. at 1278.

The court also found that it was very unlikely that Hammermill would manipulate its purchased paper distributors in a way that would harm its competitors’ ability to sell to them. Among other considerations, the court noted that Hammermill did not—and could not—manufacture every line of product that printers needed and merchants distributed. “Any attempt to force Hammermill lines on [the paper merchants] would destroy the value of these assets” because “they must offer a wide variety” of products “that no single manufacturer can supply.” Id. at 1285. Entry barriers into the paper merchant business were low, and salesmen who could not meet the demand of their printer-customers could easily go work at a different merchant or set up their own. Id.

Finally, because the acquisitions of the distributors had taken place many years before the DOJ sued Hammermill, the court was able to scrutinize the actual competitive effects for these acquisitions. The court found that Hammermill’s motivation was not to foreclose competing suppliers from accessing the merchants, but was instead to preserve the independent paper merchant distribution system. Id. at 1288-89. Consistent with this finding, and with the court’s conclusion that there were disincentives from using paper merchants to foreclose competition from other suppliers, it found that Hammermill had been using the distributors as “independent profit centers” and that they were profitable, at least in part, because they also contracted with other manufacturers. Id. at 1291.

Throughout its opinion, the court frequently referenced Brown Shoe Co. v. United States, 370 U.S. 294 (1962), a case involving a partial-vertical merger where an effort to block the merger was successful. It noted that the Brown Shoe court found the horizontal aspects of the merger to be more concerning than the vertical aspects, particularly how the combined entity would control a large market share of retail shoe stores in certain cities. Id. at 1281. The Brown Shoe court found the vertical arrangement to be unlawful because the president of the manufacturer buying the independent chain of shoe stores testified that it would “use its ownership of Kinney to force Brown shoes into Kinney stores. Thus, in operation this vertical arrangement would be quite analogous to one involving a tying clause.” Id. at 1287(quoting Brown Shoe Co., 370 U.S. at 331-32). In this way, the vertical and horizontal aspects of the merger were intertwined in their impact on competition; though mergers of manufacturers and retailers had been “primarily vertical in their aim and effect . . . they have had an additional important impact on the horizontal plane” “to the extent that they have brought ever greater numbers of retail outlets into fewer and fewer hands,” foreclosing independent shoe manufacturers from selling to markets that was previously open to them. Brown Shoe Co., 360 U.S. at 332, 345.

Though decided over forty years ago, under a different set of DOJ Merger Guidelines, Hammermill provides some insight into how Judge Leon may think about the AT&T-Time Warner suit when he hears the case. The court’s definition of the relevant market—like in all antitrust cases—will be crucial, as will the evidence concerning how AT&T plans to use Time Warner’s content after AT&T has control over it. Whether AT&T plans to “tie” together its distribution with Time Warner’s content may be an important factor in gauging the legality of the acquisition. AT&T has proposed a remedy to address these concerns: currently Time Warner content distributors will be able to seek arbitration if they feel they are being overcharged for seven years following the merger. Though it does not have a post-acquisition history to rely on, the court may also look to how the merger of Comcast and NBC Universal has impacted competition and how effective the DOJ’s remedies have been.

We will continue monitoring the DOJ’s suit against the AT&T-Time Warner merger as it unfolds.

[1] The 2011 merger between Comcast and NBC Universal raised similar antitrust concerns about video content programming and distribution; the DOJ eventually approved the proposed joint venture while imposing certain conditions, including mandatory licensing of NBC Universal’s content to online video distributors on reasonable terms; arbitration of licensing disputes; and a prohibition on discrimination against the transmission of online video distributors’ traffic on Comcast’s networks.